What is a Treasury Bill?
A Treasury Bill, or T-bill, is short-term debt issued and backed by the full faith and credit of the United States government. These debt obligations are issued in maturities of four, 13 and 26 weeks in various denominations as low as $1,000. Learn how to buy US Treasury bonds and T-bills online through TreasuryDirect.
How Treasury Bills Work
T-Bills are issued at a discount to the maturity value. Rather than paying a coupon rate of interest, the appreciation between issuance price and maturity price provides the investment return.
For example, a 26-week T-bill is priced at $9,800 on issuance to pay $10,000 in six months. No interest payments are made. The investment return comes from the difference between the discounted value originally paid and the amount received back at maturity, or $200 ($10,000 - $9,800). In this case, the T-bill pays a 2.04% interest rate ($200 / $9,800 = 2.04%) for the six-month period. In other words, you would pay $9,800 for the T-Bill and get $10,000 back ($9,800 principal + $200 interest) in six months.
Why Treasury Bills Matter
T-bills are considered the safest possible investment and provide what is referred to as a 'risk-free rate of return,' based on the credit worthiness of the United States of America. This risk-free rate of return is used as somewhat of a benchmark for rates on municipal bonds, corporate bonds and bank interest.
In addition, because T-bills are very short-term investments (as opposed to Treasury notes and Treasury bonds) there is very little interest rate risk. When interest rates rise, the price of fixed-income securities falls as the relative value of their future income stream is discounted. However, short-term securities are much less affected than long-term securities because higher rates will have a very limited effect on future income streams.
Treasury interest is also exempt from state and local taxes because of the law of reciprocal immunity, which stipulates that states cannot tax federal securities and vice versa.
How to Calculate Interest on a Treasury Bill
What if you only know the annualized interest rate (or yield) that the T-bill is paying? How do you calculate interest on a T-bill if its maturity date is in less than one year?
Here's a way to figure that out. Let's say you want to buy a one-month (aka 28-day or 4-week), $1,000 T-bill with an annualized interest rate of 2.098%. We can figure it like this:
$1,000 x 0.02098 = $20.98 interest paid per year
Of course, since it's just a one month T-bill, we'd take that annual amount and divide by 12:
= $20.98 / 12 months = $1.75 interest in one month for $1,000 invested
However, rather than receiving interest on your investment, you would simply buy the T-bill at a discounted price of $998.25 ($1,000 - $1.75 interest) and redeem the bill at the end of the one-month maturity term for the full $1,000.